The following post comes to us from Benjamin Hermalin, Professor of Finance and Economics at the University of California, Berkeley; and Michael Weisbach, Professor of Finance at Ohio State University.
Corporate disclosure is widely seen as an unambiguous good. In our paper, Information Disclosure and Corporate Governance, forthcoming in the Journal of Finance, we show that this view is, at best, incomplete. Greater disclosure tends to raise executive compensation and can create additional or exacerbate existing agency problems. Hence, even ignoring the direct costs of disclosure (e.g., meeting stricter accounting rules, maintaining better records, etc.), there could well be a limit on the optimal level of disclosure.
The model used to study disclosure reflects fairly general organizational issues. A principal desires information that will improve her decision making (e.g., whether or not to fire the agent, tender her shares, move capital from the firm, adjust the agent’s compensation scheme, etc.). In many situations, the agent prefers the status quo to change imposed by the principal (e.g., he prefers employment to possibly being dismissed). Hence, better information is view asymmetrically by the parties: It benefits the principal, but harms the agent. If the principal did not need to compensate the agent for this harm and if she could prevent the agent from capturing, through the bargaining process, any of the surplus this better information creates, the principal would desire maximal disclosure. In reality, however, she will need to compensate the agent and she will lose some of the surplus to him. These effects can be strong enough to cause the principal to optimally choose less than maximal disclosure.
